Research on the Allocation of Cash Flow Rights and Control Rights in Venture Capital Financing Contract

Yunfei Li, Zongfang Zhou

.

DOI: 10.4236/me.2012.31008                

Abstract

In view of the allocation of cash flow rights and control rights in venture capital firms, a financing contract model is set up by introducing the entrepreneur’s self-owned capital in this paper. This paper analyzes the affecting factors and mechanism to the allocation of cash flow rights and control rights, shows the relationship between cash flow rights and control rights, gives the bargain intervals of the entrepreneur and the venture capitalist about the allocation of cash flow rights and control rights. It is shown that the more the entrepreneur’s self-owned capital and the higher the venture capitalist’s evaluation of the venture project and the ability of the entrepreneur, the fewer cash flow rights and control rights the venture capitalist will want; the relationship between cash flow rights and control rights of the venture capitalist is complementary but not corresponding, so the result provides a theoretical explanation for Kaplan and Stromberg’s empirical researches about the disproportion between cash flow rights and control rights in venture capital firms.

Keywords

Venture Capital Firms; Financing Contract; Self-Owned Capital; Cash Flow Rights; Control Rights

Conflicts of Interest

The authors declare no conflicts of interest.

References

[1]	P. Aghion and P. Bolton, “An Incomplete Contract Approach to Financial Contracting,” Review of Economic Studies, Vol. 59, No. 3, 1992, pp. 473-494. doi:10.2307/2297860
[2]	Y. Zeng, W. X Guo and D. W. Li, “Survey of Empirical Studies on Contracting and Governance of Venture Capital Investments,” Journal of Management Sciences in China, Vol. 11, No. 1, 2008, pp. 110-121. doi:10.2307/2118355
[3]	M. Dewatripont and J. Tirole, “A Theory of Debt and Equity: Diversity of Securities and Manager Shareholder Congruence,” Quarterly Journal of Economics, Vol. 109, No. 3, 1994, pp. 1027-1054.
[4]	E. Berglof, “A Control Theory of Venture Capital Finance,” Journal of Law, Economics and Organization, Vol. 10, No. 4, 1994, pp. 247-267.
[5]	S. Kaplan and P. Stromberg, “Financial Contracting Theory Meets the Real World: Evidence from Venture Capital Contract,” Review of Economic Studies, Vol. 70, No. 2, 2003, pp. 281-315. doi:10.1111/1467-937X.00245
[6]	T. Hellmann, “The Allocation of Control Rights in Venture Capital Contract,” Rand Journal of Economics, Vol. 29, No. 1, 1998, pp. 57-76. doi:10.2307/2555816
[7]	G. Gebhard and K. M. Schmidt, “Conditional Allocation of Control Rights in Venture Capital Finance,” 2006. http://papers.ssrn.com/sol3/papers.cfm
[8]	S. An, J. Wang and L. He, “Allocation of Control Rights between Venture Capitalist and Entrepreneur by Game Theory,” System Engineering Theory and Practice Academic Journal, Vol. 22, No. 12, 2002, pp. 81-87.
[9]	S. An, J. Wang and L. He, “Study on Allocation Model of Control Rights in Venture Firms,” Journal of Systems Engineering, Vol. 19, No. 1, 2004, pp. 38-44.
[10]	Z. X. Yan and F. Y. Fei, “Control Allocation in Firm Financings and Entrepreneur’s Incentive,” Economic Research Journal, Vol. 56, No. 2, 2007, pp. 111-122.
[11]	L. Wang, X. H. Dang and L. P. He, “Research on the Selection and the Influencing Factors of Control Rights Structure in Venture Capital-backed New High-tech Firms Based on Incomplete Contract,” Chinese Journal of Management Science, Vol. 17, No. 5, 2009, pp. 166-174.
[12]	S. C. Wang and Y. Zeng, “Convertible Securities and Control Rights in Ventures Firm,” Journal of Systems Engineering, Vol. 25, No. 2, 2010, pp. 209-215,276.
[13]	J. J. Li, F. Y. Fei and Z. L. Zheng, “Convertible Preferred Equity and Efficiency of Venture Capitalist Controlling —An Incomplete Contract Perspective,” Journal of Ma- nagement Sciences in China, Vol. 13, No. 2, 2010, pp. 41-49.
[14]	B. Wu and M. F. Huang, “Firm Performance, Human Resources’ Characteristics of Senior Managers and Con- trol Right Allocation: Evidence from Small and Medium Board’s Venture Enterprises in China,” China Soft Science Magazine, Vol. 17, No. 4, 2011, pp. 161-174.
[15]	A. C. Cooper, W. C. Dunkelberg and C. Y. Woo, “Entre- preneurs Perceived Chances for Success,” Journal of Business Venturing, Vol. 3, No. 1, 1998, pp. 97-108.
[16]	F. Cornelli and O. Yosha, “Stage Financing and the Role of Convertible Securities,” Review of Economic Studies, Vol. 70, No. 1, 2003, pp. 1-32. doi:10.1111/1467-937X.00235
[17]	M. S. Klaus, “Convertible Securities and Venture Capital Finance,” Journal of Finance, Vol. 58, No. 3, 2003, pp. 1139-1166. doi:10.1111/1540-6261.00561
[18]	T. Tirole, “Corporate Governance,” Economitrica, Vol. 69, No. 1, 2001, pp. 1-35. doi:10.1111/1468-0262.00177
[19]	A. Dyck and L. Zingales, “Private Benefits of Control: An International Comparison,” Journal of Finance, Vol. 59, No. 2, 2004, pp. 537-600. doi:10.1111/j.1540-6261.2004.00642.x
[20]	R. Dessí, “Venture Capitalists, Monitoring and Advis- ing,” 2009. http://neeo.univ-tlse1.fr/2294/1/venturecapitalists.pdf
[21]	E. Ramy and G. Arieh. “A Multi-period Game Theoretic Model of Venture Capitalist and Entrepreneurs,” European Journal of Operational Research, Vol. 144, No. 3, 2003, pp. 440-453.
[22]	J. Gu and Z. F. Zhou, “Termination Decision Analysis for Venture Capital Based on Signal Learning,” Chinese Journal of Management, Vol. 6, No. 10, 2009, pp. 1306- 1312.